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Divergence vs. Convergence What's the Difference?
Select personalised ads. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors. Some foreign exchange traders regard oscillator divergences as the holy grail of technical analysis. Others consider these elusive chart patterns to be virtually useless. The truth probably lies somewhere in between. The purpose of classic divergence is to recognize a technical imbalance between price and oscillator, with the assumption that this imbalance will signal an impending directional change in price.
The first trade turned out like a dream. The second left much to be desired.
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Figure 1. For the first signal in dark red , which occurred between November and December of , we have almost a textbook case of classic bullish divergence. Price drastically hit a lower low while the MACD histogram printed a very obvious higher low. According to proponents of divergence trading, this type of price-oscillator imbalance foretells a price correction of the imbalance.
In this case, the correction in price would need to have been a directional change to the upside. The following are the three ways to interpret MACD:. Centre Line Crossover. MACD Benefits. Drawbacks of MACD. Divergence When the price of a currency pair deviates from the MACD, we can interpret it as the end of the current trend. MACD Benefits One of the main benefits of this indicator is that it can be used both as a trend and as a momentum indicator.
MACD can be a great way to quickly evaluate the market momentum and trend. Day traders frequently use the MACD for predicting short term market trends. Another serious drawback of the MACD is that it tends to be more descriptive than predictive- hence it is more suited to understanding the market trends rather than predicting it. MACD is sometimes very difficult to interpret and use effectively, especially for novice forex traders.
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9 Rules for Trading Divergences
Sign Up Enter your email. Did you like what you read? Let us know what you think! We set a stop-loss a little higher than the next local high red line. To fix the profit, we shall use a take-profit that is twice as big as the stop loss green line.
The price goes down, and we take the profit. Regular bullish divergence is a perfect reversal signal.
Moving Average Convergence Divergence
Just like with the bearish divergence, we should use the trendline breakout as an entry signal. The above chart displays a perfect bullish divergence signal. The price is in the bear trend. Sometime later, there are two consecutive regular bearish divergences. I marked them with different colors. I will explain this phenomenon later.
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Now, we should just take this fact into account. Now, we just consider it just like a strong reversal signal. When you use trendline to detail entry points, you should be able to draw it correctly. The downward trendline starts from the first trend high to the last local highest high in our example.
In the previous example, with the bullish trend, the approach was the same, but the trendline was drawn across the lows. Let us go back to our example. After the first bar closes above the trendline, we enter a long. I marked it with the blue horizontal level on the chart. Like in the previous example, we set a stop loss a little lower than the last local low.
The take profit is twice as big as the stop loss. I should note that taking a profit that is twice as long as the stop loss is not always efficient. In our case, we have to wait for a profitable trade for a month. You can exit the trade based on the combination of the divergence signal with other indicators and trading strategies.
I will deal with this in detail a little later. Unlike the previous two divergence types, this signal means the trend continuation. You can use extended bearish divergence to enter in the trend, following a failed reversal. The above chart displays a common case of extended divergence. There is extended bearish divergence, where the indicator hits higher highs while the price highs are getting lower marked with blue lines. This signal should be followed by a false trend reversal. To determine the entry point, we use the moving averages MACD, namely their breaking the zero level downside.
Usually, when the MACD moving averages go into the positive zone, it is seen as a trend reversal signal. However, taking into account hidden bearish divergence, we expect a false breakout of this level. So, when the indicator goes back into the negative zone, we enter a short trade.
A stop loss is set a little higher than the first high of the convergence formed red line. It is clear from the above chart that the take profit, which is two times more than the stop loss, is hit by the price and exits our trade with the profit. This signal mirrors the previous one. It also suggests the trend, this time uptrend, will continue. It is clear from the above chart that the MACD histogram forms lower lows, while the price chart indicates the uptrend.
I marked the extended bullish divergence with the blue lines. Like in the previous case, we expect a false reversal of the trend. The MACD moving average do not confuse with the signal line! This is a buy signal! I marked it with the blue level on the currency pair price chart. We set the stop loss like in the case with the previous trade; only it is below the price low.
The target, double distance of the stop loss, is reached quite soon.
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It is quite a common situation in trading divergence signals. Let explore the third point in more detail. To filter out false signals, you can use supplementary technical tools, price action patterns, graphic chart patterns. Let us study how to filter false signals using Bollinger bands. The above figure shows an example of a false divergence between the price chart and the MACD histogram.
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Following the divergence signal, the price starts moving down, and even the MACD moving averages foes into the negative zone. However, the price fails to consolidate below Bollinger bands, which means the price is likely to be consolidating rather than trending. The Bollinger bands get close in the zone of the red circle, where the price goes into the opposite zone. It cancels the bearish reversal signal.